What are nonqualified stock options (NSO)?
Nonqualified stock options (NSO) are a type of employee stock compensation where you can buy your employer's common stock for a discounted price. This does not have the tax advantages of incentive stock options (ISO).
Income from the exercise of the option
When you exercise your options, you must recognize ordinary wage income on the discount you received for the stock. The wage income is equal to the difference between the discounted exercise price you paid for the stock and the price that everyone else must pay (fair market value). The income from the discount is reported on W-2, Box 1.
For example, if you exercise nonqualified stock options and receive 100 shares of stock at a grant price of $10 per share, but the actual value of the stock on the day you exercised the options is $50 per share, then the discount you received when exercising the options is $40 per share or $4,000 for the 100 shares of stock. The $4,000 difference is included as wages on your W-2 along with any other wages for the year. Your cost basis for the 100 shares of stock is $5,000, which is made up of the $1,000 you paid out of pocket to exercise the options and the $4,000 included as wages on your W-2.
Capital gain income
When you sell stock purchased with a nonqualified stock option, you'll need to report capital gain income. If you sell the stock right after exercising your option, all the income from the NSO is taxed at ordinary income tax rates. If the newly acquired stock is held for at least a year, the sale of the NSO stock will be taxed at lower, long-term capital gains rates.
If you immediately sell the stock after you exercise the options, then the date sold and date acquired will be the same date and you'll have very little gain or loss from the sale of the stock. Note: You'll need to make sure your employer has included the correct amount of income on your W-2. This should be reported in W-2, Box 12, Code V. If this is not there, ask your employer for a corrected W-2.
Income from the exercise of the option
When you exercise your options, you must recognize ordinary wage income on the discount you received for the stock. The wage income is equal to the difference between the discounted exercise price you paid for the stock and the price that everyone else must pay (fair market value). The income from the discount is reported on W-2, Box 1.
For example, if you exercise nonqualified stock options and receive 100 shares of stock at a grant price of $10 per share, but the actual value of the stock on the day you exercised the options is $50 per share, then the discount you received when exercising the options is $40 per share or $4,000 for the 100 shares of stock. The $4,000 difference is included as wages on your W-2 along with any other wages for the year. Your cost basis for the 100 shares of stock is $5,000, which is made up of the $1,000 you paid out of pocket to exercise the options and the $4,000 included as wages on your W-2.
Capital gain income
When you sell stock purchased with a nonqualified stock option, you'll need to report capital gain income. If you sell the stock right after exercising your option, all the income from the NSO is taxed at ordinary income tax rates. If the newly acquired stock is held for at least a year, the sale of the NSO stock will be taxed at lower, long-term capital gains rates.
If you immediately sell the stock after you exercise the options, then the date sold and date acquired will be the same date and you'll have very little gain or loss from the sale of the stock. Note: You'll need to make sure your employer has included the correct amount of income on your W-2. This should be reported in W-2, Box 12, Code V. If this is not there, ask your employer for a corrected W-2.
